Target Net Income
Target net income is the target profit that top management or shareholders set for the company to achieve in an accounting period. It is the goal for company to achieve in a year. At the beginning of the year, each company prepares the annual budget, which is the target for company to achieve during the year. We can not just set the target net income alone as it has a close relationship with sales, variable cost, and fixed cost.
In order to complete the target, the company needs to understand the relationship between variable cost, fixed cost, and selling price. It is usually called the cost-profit analysis. Before achieving target net income, we need to hit the sale target, budgeted variable cost, and fixed cost.
|Tax on Profit||(000)|
The top managements may have no interest in all the figures here, they just want the company to reach a certain of net income during the year. But as the management account, we have separated all the figures in order to bring a clear message to all departments. Sale departments must know about their target, production department needs to ensure that the variable cost must be within the control and the so on.
We need to calculate:
- Target Operating Income
- Target Contribution Margin
- Target Sale quantity
Target Net Income Formula
Then, Target Contribution Margin = Target Operating Income + Fixed Cost
Company ABC is preparing a budget for each department after the board of directors had set the target net income for next year. The target net income is $ 200,000, and the variable and fixed costs are:
|Selling Price||$ 100|
|Variable Cost||$ 40|
|Fixed Cost||$ 300,000|
First, we need to calculate the Net operating income.
Target Operating Income = Net Income/(1 – Tax rate)
Net Operating Income = Net Income / (1 – 30%)
Net Operating Income = 200,000/70% = $ 285,714
Second, calculate target contribution margin
Contribution Margin – Fixed Cost = Net operating Income
Contribution Margin = Net Operating Income + Fixed Cost
Contribution Margin = $ 285,714 + $ 300,000 = $ 585,714
Finally, calculate the target sale quantity
Sale quantity = Total Contribution / Contribution per unit
Sale Quantity = $ 585,714 /($100-$40) = 9,761 units
It means that Company ABC needs to sell 9,761 units to achieve a contribution margin of $ 585,714. So the company will be able to get a net operating income of $ 285, 714, and net income of $ 200,000.
Target net income is the best method which we use to make the connection between shareholder/top management and the other departments. Sale department will be notified about their target sale to support target profit. They can challenge back if it is too high and suggest any marketing strategy.
Production department must keep the cost within the standard cost otherwise it will reduce the profit. They have to control the material wastage, worker idle time and product quality. These are the factors that will impact to cost of goods sold.
It also happens to the expense such as rental, utilities, payroll, and other fixed costs, the management needs to ensure that they are not significantly increased during the year. Usually, they overestimate them around 5%-10% base on the nature of business.